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What to Expect From Baidu's Second-Quarter Earnings Report

Baidu
's
(NASDAQ: BIDU)
stock has been cut in half over the past 12 months as concerns about the search leader's slowing growth, rising expenses, and inability to counter disruptive rivals like
Tencent
(OTC: TCEHY)
and ByteDance have piled up.

The economic slowdown in China and the ongoing trade war exacerbated that pain, and a
surprise loss
in the first quarter -- the company's first loss since its 2005 IPO -- seemed to confirm those fears. Baidu and analysts have set the bar pretty low going into the Aug. 19 second-quarter report.

Revenue rose 15% annually in the first quarter, but the company expects a more muted result in the second quarter. Excluding the impact of upcoming divestments, it anticipates 1%-6% sales growth. Baidu didn't offer any bottom-line guidance, but analysts expect its earnings per ADS to decline about 72%.

Let's take a look at the key things to look for when the company reports.

A man in a business suit, with his hands to his head, stands in front of a wall on which a declining chart is drawn in chalk.

Image source: Getty Images.

Ad sales in the spotlight

Ad sales accounted for 73% of Baidu's revenue last quarter. Unfortunately, the slowdown in the Chinese economy, softer demand from more tightly regulated sectors (including healthcare, gaming, and fintech), and competition from other platforms like Tencent's WeChat have caused that core business's growth to hit a wall over the past year.

Metric

Q1 2018

Q2 2018

Q3 2018

Q4 2018

Q1 2019

Online marketing revenue growth (YOY)

23%

25%

18%

10%

3%

YOY = year-over-year. Data source: Baidu.

Baidu's ad sales will likely remain soft in the second quarter, but investors should pay attention to two key things.

First, keep an eye on the company's TAC (traffic acquisition costs), which rose 41% annually last quarter and accounted for 18% of its ad revenue. If that percentage remains stable, Baidu isn't spending too much to attract advertisers. For context,
Alphabet
's Google spent 22% of its ad revenue on TAC last quarter. But if Baidu's TAC percentage rises significantly in the second quarter, it would indicate that it's struggling to retain advertisers.

Second, investors should see if the healthcare, gaming, and fintech markets generate better ad sales as they move past the damage from past government crackdowns, including the 2016 crackdown on deceptive healthcare ads, the
2018 freeze
on new game approvals, and the ongoing crackdown on online lending and fintech services.

Keep an eye on those expenses

Baidu's first-quarter loss was mostly attributed to an ill-conceived TV marketing blitz during China Central Television's New Year Gala. The costly ad campaign caused Baidu's selling, general, and administrative expenses to nearly double annually, but didn't boost its core ad revenue. Baidu hopefully learned its lesson and avoided similar ad campaigns in the second quarter.

However, Baidu's R&D expenses, which rose 26% annually last quarter, will likely keep rising as it continues to expand its ecosystem with its mini-program platform (which challenges WeChat's similar platform), smart speakers, and investments in next-gen technology like its DuerOS assistant, Haokan short video app, and driverless cars.

Icons for calls, music, groceries, and more float around a smart speaker to which two people are talking.

Image source: Getty Images.

The growth of its ecosystem

During the first quarter, Baidu stated that its installed base for DuerOS grew 279% year-over-year to 275 million devices and monthly voice queries jumped 817% to 2.37 billion. Its mini programs (apps) had 181 million monthly active users (MAUs), representing 23% growth from the previous quarter. Haokan, which was developed to counter ByteDance's TikTok, grew its daily active users (DAUs) 768% annually and 16% sequentially to 22 million. Investors will be looking to see if these platforms kept growing in the second quarter.

The growth of the video streaming platform
iQiyi
(NASDAQ: IQ)
, which Baidu retains a majority stake in, will also likely remain a blessing and a curse. On one hand, it boosts Baidu's total revenue, broadens its ecosystem's reach, and challenges Tencent Video as the top video platform in China. On the other hand, Baidu still covers a large portion of iQiyi's content costs and those expenses are deadweight on its bottom line.

Investors should see if Baidu steps back from iQiyi (either by reducing its stake or letting it cover its own content costs). Baidu's revenue could take a short-term hit, but the earnings boost could be worth it.

Smarter business strategies

As a Baidu investor, I'd like to see the company concentrate on improving its core search and advertising business instead of pursuing hot next-gen markets, stop its "brain drain" issues (which claimed its search chief and other key executives earlier this year), and avoid meaningless gestures like
terribly timed buybacks
.

I'm setting the bar pretty low for Baidu, but if it fails to show signs of improvement, I'll consider reducing my stake and buying more promising Chinese tech stocks like Tencent,
Alibaba
,
Momo
, or
NetEase
instead.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors.
Leo Sun
owns shares of Baidu and Tencent Holdings. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Baidu, NetEase, and Tencent Holdings. The Motley Fool recommends iQiyi and Momo. The Motley Fool has a
disclosure policy
.